although there are opportunities in emerging markets investor aversion is extreme and this is damaging returns
In this blog we will look to highlight some key thoughts from the Investec Investment Conference which took place on 21 January 2016. These are the opinions of Investec and this is not an endorsement of what they have said. It is worth adding that there are no house views and therefore the comments below may differ between managers.
In this part of the conference Philip Saunders shared his thoughts on the global economy.
China – the currency devaluation caught the markets by surprise and unnerved many. This has made many feel that the policy makers are not in control, don’t really know what they are doing and therefore the natural conclusion is that we are facing a ‘hard’ landing. It will not be happy for the markets!
Philip feels this is overdone. China is facing an unprecedented situation and to some extent they are making it up as they go along but they are also very quick to learn. His view is that if you avoid being sucked into the noise then the reality is that China will slow but not crunch.
US – the markets are always going to be uncomfortable with tightening but rate rises are going to be small. The reality is that the US economy is in very good shape and fears of a recession are overdone. There are a broad range of indicators which would lead to the consensus of a recession and currently these are not showing this. If there is one ‘concern’ it is that the US consumer is saving too much and they need to be spending.
Global growth – the signs for a recession are when the global banks have run out of ammunition. The challenge is that growth globally is weak or flat (but not negative) which brings volatility to the markets which are driven by news flows (good or bad).
We are certainly in bear market territory and to come out of that there needs to be more certainty. Earnings continue to be soggy and disappoint, any downgrades seem to undermine equity markets. Oil prices unsettle the markets but this is down to a supply problem rather than a demand problem and Philip believes we are coming to an end of the low end of oil prices. For these reasons equity prices don’t seem excessive.
Philip sees opportunities in Japan and Europe but feels it is too early for emerging markets. His feeling is that although there are opportunities in emerging markets investor aversion is extreme and this is damaging returns, it is however undervalued. On currency he feels the US dollar has peaked and this will weaken with the Yen and Euro rising.
In summary the time to worry is towards the end of the cycle and there is no evidence we are at this stage. Emerging markets have slowed and it is now for the developed markets to pick up the slack. With slow growth it is difficult to see an end to the nervousness in the markets and volatility is something investors will need to accept moving forward.
Quality investing in a low growth world
In the next part of the conference Simon Brazier discussed investing in a low growth world.
Simon started by explaining that from 2009 onwards it was an ‘easier’ time to be investing. But from 2013 we entered a very different environment and this will exist for some time to come.
2009 was driven by a re-rating of valuations and these are now pretty full with little room for disappointment. We are now in a low growth world and that is not going to change (QE exit, regulation, commodity prices, global growth shocks etc).
Therefore, to invest in this environment it is about finding companies which can help themselves. This could be self-help or recovery opportunities or re-investing cash flow. For Simon valuation is important but it is not a reason not to invest.
The whole process for them is looking at what a company could be valued at in 3 to 5 years’ time. As an example Booker has seen its shares rise rapidly (from 30p) but even at today’s price Simon believes there remains value. This is about seeking out a quality business model. If you compare Booker to Tesco, you can quickly see how one strategy worked well and one didn’t it is therefore about avoiding strategies which he believes won’t work.
Equally Simon worries about risk and invests where there is the least business risk. It means that there is a mix of holdings from strong franchises (those stocks he could go away and leave and know they will deliver) to hidden gems.
As Simon concluded his update he added that volatility is not unusual. Over 116 years the return on UK shares was around 5% p.a. During these periods investors would likely get a 25% return one year as they would a -15% loss. His point in all of this is markets live through fear and greed, the markets between 2009 and 2013 behaved in an uncharacteristic way. What has happened since 2013 is a more normalised market, and this is something people have to accept. Investing in this market is hard.
Finding value in UK equities
In the final update Alastair Mundy explained the process of investing in out of favour and cheap companies.
Alastair invests in unloved companies and as he explained even smart people do dumb things. As a result of these dumb things shares go down a lot. In his view he looks for companies where the share has dropped 50% from the peak over a 7-year period. But not all companies that go down will go back up.
Before purchasing a company, it is about looking at the reasons why you may have purchased the company in the first place and whether the business is in a position where it can turn things around. The problem is that as he descried we are in a “value hell” period where things just seem to be going lower but with this type of investing it is about sticking with it because it will bounce.
For his portfolio the areas of value are food retailers, banks, oil and resources. He discussed two topical areas – banks and food retailers.
With banks the reasons not to invest include transparency, regulation, fines, government holdings and lack of dividends. Alastair would argue that the banks are more transparent than they were 7 years ago, regulation may be coming to an end, fines are coming to an end, government holdings are already priced in and banks are starting to pay dividends.
Additionally, the banks have been stress tested to a point where it assumes a 35% to 40% cut in house prices and all passed. The point being is that these are not the same businesses as they were 7 years ago. These are quality, staple and durable businesses.
Turning to food retailers he explained that Carrefour is a template for the recovery of food retailers. Similar to Tesco’s it was struggling and the argument against it turning things around were that it was too big, it couldn’t compete and it was too expensive. In France discount supermarkets make up a larger part of the market and against this Carrefour has reduced prices in line with competitors and started treating customers fairly. As a result, it is now coming back into favour.
His belief is that the likes of Tesco’s and Morrison’s are doing the right things and they can return. It is also worth adding that only 5% of shoppers use the likes of Aldi and Lidl for their full shop preferring the bigger supermarkets.
With all of these it is not an overnight change but should be seen as a long term investment.
In summary Alastair believes to drive value in this environment is to find cheap unloved companies but at the same time avoiding those that will continue to decline. There are clearly periods were value stocks suffer more and we are seeing this at the moment but for the patient investor this can be a rewarding part of the market to invest in.
Note: This is written based on the views shared by Investec in January 2016, they do not necessarily represent our views. The reader should accept that by its very nature many of the points are subjective and opinions of Investec. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this summary must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.